United States

IRS disallows abandonment loss for costs related to postponed transaction

TAX ALERT  | 

On Aug. 2, 2013, the IRS released a directive stating that a taxpayer was not entitled to an abandonment loss for certain costs incurred in pursuing a plan of reorganization and public offering where it was determined that the plan was not terminated, but rather postponed and ultimately completed. Despite the IRS’s position taken in the directive, a review of the facts shows that the taxpayer had a supportable position to write off the costs related to the terminated plan and that the relevant authorities would continue to support the deduction of abandonment losses where a similar but separate transaction is subsequently entered into. However, FAA 20133101F serves as a good reminder that mutually exclusive transactions must be carefully analyzed before writing off any related costs.

Discussion

Although the FAA is highly redacted, it appears the taxpayer adopted a plan of reorganization and public offering (the first plan) whereunder it would convert to a publicly held corporation through a public offering of a certain amount of its stock. In pursuance of the first plan, several transactional costs were incurred,1 but before the reorganization and public offering could take place, the taxpayer’s board of directors voted to postpone the transaction and formally terminate the plan. Subsequently, a new but similar plan of reorganization and public offering (the second plan) was adopted and ultimately completed.

The taxpayer claimed a deduction under section 165(a) for the costs incurred in pursuing the first plan, arguing that such expenses were properly deductible as abandonment losses.2 In determining whether the taxpayer sustained a loss with respect to costs incurred in relation to the first plan, the IRS focused its analysis on the question of whether the taxpayer was (1) pursuing multiple separate transactions (in which case costs allocable to abandoned transactions would be deductible, even if other transactions were consummated), or (2) considering multiple exclusive alternatives in pursuing a single transaction (in which case costs could not be deducted under section 165 unless the entire transaction was abandoned). Despite noting that several cases have held that abandonment losses related to one transaction may be allowable even if the taxpayer later proceeds with a similar transaction, the IRS stated that the relevant inquiry in determining whether multiple separate transactions were being contemplated is whether the taxpayer could elect to proceed with more than one proposed transaction or whether the taxpayer would be forced to abandon alternative plans in order to proceed with the desired plan. The IRS ruled that, based on this inquiry, the taxpayer at issue could not deduct its costs under section 165 because it would have had to abandon the first plan in order to proceed with the second plan. As such, the two plans were mutually exclusive alternatives to completing a single transaction.3

Based on the limited facts provided, it appears the taxpayer had a supportable position to claim an abandonment loss even though it subsequently entered into a similar transaction. For example, in a series of cases involving tobacco and furniture company taxpayers, the Tax Court held that abandonment losses were allowable upon the termination of each of a series of proposals related to a plan of distribution or merger, despite the fact that the plan of distribution or merger was ultimately consummated in a subsequent transaction.4 In the FAA, the IRS discusses these cases but distinguishes them by stating that the taxpayers in such cases “incurred costs in exploring transactions that were clearly distinct from the transaction in which each taxpayer ultimately engaged.” However, based on the limited facts provided in the FAA, the taxpayer’s facts appear to be in line with those contemplated by the Tax Court in its prior holdings and, as such, do not appear to be distinguishable.

Implications

The FAA serves as a good reminder that mutually exclusive transactions must be carefully analyzed before any costs are written off as abandonment losses. Taxpayers pursuing one or more forms of a transaction should work with their tax advisors to analyze whether costs related to any abandoned transactions constitute deductible losses versus capitalizable costs of the ultimately consummated transaction.

1  Such costs included fees for: a state tax opinion; printing; a business plan; regulatory filings; an appraisal; postage; and legal, audit and advisory, and investment banking services. The taxpayer ultimately conceded that the expenditures for the state tax opinion, regulatory filings and appraisal had future value and thus should not have been deducted under section 165. However, the taxpayer maintained its position that the other costs retained no future value after the first plan was terminated and were thus properly deductible as abandonment losses.

2  Generally, costs incurred to facilitate any restructuring, recapitalization or reorganization of a business entity must be capitalized under Reg. section 1.263(a)-5. However, under section 165 and the regulations thereunder, losses incurred from the termination of a proposed transaction may generally be deducted.

3  The IRS stated that the taxpayer never abandoned its first plan, since, at the successful completion of the second plan, the taxpayer would be in the same position it would have been in had the first plan been completed (i.e., a portion of the taxpayer would be publicly owned under either plan).

4  See Tobacco Products Export Company v. Commissioner, 18 T.C. 1100 (1952); Portland Furniture Manufacturing Co. v. Commissioner, 30 BTA.878 (1934); and Doernbecher Manufacturing Co. v. Commissioner, 30 BTA 973 (1934).

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